FT: US Public Pensions Face $2.5 Trillion Shortfall

Public pensions across the United States face a $2.5 trillion shortfall that will force states and municipalities to sell assets and slash public services, says Orin Kramer, former head of the New Jersey pension fund.

The recession, coupled with financial mismanagement such as underfunding retirement obligations, is fueling the problem.

"States face cost pressure, most prominently from retirement benefits and Medicaid [the health program for the poor]," Kramer tells the Financial Times.

"One consequence is that asset sales and privatization will pick up. The very unfortunate consequence is that various safety nets for the most vulnerable citizens will be cut back."

Kramer’s estimates are based on assets and liabilities of the top 25 public pension funds at the end of 2010, the newspaper reports, adding the figure is up from a $2 trillion gap predicted by the end of 2009.

While some governments will feel strain, widespread defaults aren't likely.

“I don’t assume that you will have that level of defaults just because there are various remedies, including asset sales, that you can engage before you have to default,” Kramer says.

"States have an interest in their major municipalities not defaulting."

Municipal bonds have taken a beating on fears that states, cities and towns will have trouble servicing their debts, especially in wake of start analyst Meredith Whitney's warning that local governments will default on hundreds of billions in debt.

Some, however, say default fears are overblown, and while investors should do their homework, they should not avoid local debt altogether.

"They have to be extremely picky," said Marilyn Cohen, author of "Surviving the Bond Bear Market," tells the Baltimore Sun.